The SEC on Wednesday approved disclosure rules designed to increase
transparency around companies’ use of so-called “conflict minerals”
and payments to governments for access to natural resources.

The rules, advocated by certain human rights groups, will implement
two sections of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010, P.L. 111-203.

But they contain disclosure provisions that divided the SEC
commissioners’ votes and have been criticized by some business groups
as being unworkable, in the case of conflict minerals, and likely to
put U.S. companies at a competitive disadvantage, in the case of the
natural resource payment reporting requirements.

Section 1502 of the Dodd-Frank Act requires yearly reporting on
whether U.S. public companies use conflict minerals originating in the
Democratic Republic of the Congo (DRC) or neighboring countries.
Section 1504 requires U.S. public companies that extract resources to
disclose in an annual report how much they pay the U.S. and foreign
governments around the world for access to oil, natural gas and
minerals.

The conflict minerals statute was included in the Dodd-Frank Act
with the intent of cutting off funding for warlords in the DRC. Armed
groups there are accused of atrocities against local populations and
funding their activities by using forced labor to mine for gold and
other minerals used in products ranging from jewelry to cell phones.

By requiring companies that use conflict minerals to document their
chain of custody, the statute aims to choke off the market for raw
materials produced in mines using forced labor. The regulation intends
to use transparency to prompt companies to shun conflict minerals.

Human rights groups had encouraged the regulation. In a comment
letter, seven human rights groups said the rule has “enormous
potential” to transform the conflict.

“While the DRC government must take up its responsibilities to
protect civilians and establish governance and infrastructure,
U.S.-based companies and consumers also have a crucial role,” the
groups wrote. “We are all connected to the conflict through the
minerals we use in so many everyday items.”

Business groups disappointed

But some business groups say requiring companies to audit their
supply chains and monitor those of their vendors is unreasonable
because of the complexity of the supply chains. In an opinion piece
for The
Hill, Tom Quaadman, vice president of the Center for Capital
Markets Competitiveness at the U.S. Chamber of Commerce, said the rule
will create an unworkable regulatory regime that will be exploited by
bad actors and difficult for honest market participants to implement.

The rule passed on a 3–2 vote. Dissenting commissioners Troy Paredes
and Daniel Gallagher said the implementation of the rule did not fit
the SEC’s mission of protecting investors. Gallagher said it was
unclear whether the rule would have the unintended consequence of
harming the populations it aimed to protect because it could create
what amounts to an economic embargo of the DRC and other nations as
U.S. issuers pull their business from the region altogether in an
abundance of caution.

Businesses will be required to determine if the products they
manufacture or contract to manufacture contain conflict minerals. If
they use such minerals, they will need to determine whether they
financed armed groups in the DRC or its adjoining countries.

Due diligence requires an independent private-sector audit of a
conflict minerals report companies will file with the SEC. The audit
must be conducted in accordance with standards set by the Government
Accountability Office (GAO), according to testimony SEC Special
Counsel John Fieldsend gave at Wednesday’s open meeting.

Companies will file their first specialized disclosure report on May
31, 2014, for the 2013 calendar year. Companies will be required to
file for a calendar year regardless of when their fiscal year ends.

Natural resources reporting requirement

Gallagher also was among those concerned about whether Section 1504
of the Dodd-Frank Act fits into the SEC’s mission. That regulation was
structured to increase accountability of leaders in resource-rich
countries with high poverty rates by requiring companies to disclose
how much they are paying for access to resources. It is hoped that
transparency would ensure that the money paid to governments is used
to benefit the entire population rather than enriching government officials.

“The final rule we consider today is in the interest of investors
and the public interest,” said Commissioner Luis Aguilar.

The regulations pursuant to Section 1504 passed by a 2–1 vote with
two commissioners recusing themselves, despite the concerns of a trade
group for the energy industry, the American Petroleum Institute (API).
API Chief Economist John Felmy called the rule a “Draconian approach
to disclosure that will unnecessarily harm U.S. competitiveness and jobs.”

Felmy said Tuesday that the rule will require publicly traded energy
firms to release commercially sensitive, detailed payment information
that state-owned foreign national businesses – such as China National
Petroleum Corp. and Russia’s Gazprom – could use to determine
strategies and resource levels to win contracts.

Companies that extract resources will be required to comply with the
new rules for fiscal years ending after Sept. 30, 2013. The form must
be filed with the SEC no later than 150 days after the end of a
company’s fiscal year.

Increased disclosure, opportunity

For the required audit of conflict mineral reporting, Fieldsend, the
SEC special counsel, said the GAO staff has indicated that it plans to
refer issuers to its existing government auditing standards (commonly
referred to as the “Yellow Book”) so that the auditor can perform
either an attestation engagement or a performance audit.

The audit’s objective will be to express an opinion or conclusion as
to whether the design of the company’s due-diligence measures conforms
with the criteria set forth in the nationally or internationally
recognized due-diligence framework, and whether the company’s
description of the due diligence performed is consistent with the
process it undertook.

According to Fieldsend, the only due-diligence framework currently
available for conflict minerals reporting is provided by the
Organisation for Economic Co-operation and Development (OECD).

Fieldsend acknowledged that the auditing objective is not as
comprehensive as an objective that would require the auditor to
express a conclusion or opinion on whether the due-diligence measures
are effective or the company’s materials are conflict-free. But the
SEC said an independent opinion on whether the due-diligence framework
is appropriately designed and whether the due diligence was performed
gives investors some meaningful assurance.